The Economic Cycle Illusion

It is ingrained in the imaginations of many that a permanent “economic cycle” exists. The economy grows, it over-extends, it decreases, it over-declines, and it grows again. In short, the economy is never in balance and always over-reacting. In fact, this is wrong. And more dangerous than simply being incorrect, it encourages the government to seek to over-compensate for the misperceived failings of an illusory economic cycle.

It is common for human beings to animate things. We seek to imbue them with animate abilities in an attempt to understand what we otherwise do not. Common as this trait is, it is not illuminating. When such an approach is applied to the economy, the tendency is downright dangerous.

With the economy we frequently liken its growth to organic growth. We envision the economy like a forest – repeating infinitely its cycle of growth, death, and rebirth.

We seemingly see such a cycle played out at the micro-economic level. A single business: it enters a sector with a competitive advantage. It thrives. Eventually other firms duplicate or neutralize the business’ competitive advantage. Its growth stabilizes. Finally, new entrants possess their own competitive advantages and the original business cannot compete. It ceases to exist.

Occasionally, this process even takes place across an entire sector of the economy.

The problem with such apparently obvious analogies is that neither device is accurate. An economy is neither an organism, nor is a macro-economy simply a micro-economy on a larger scale.

That an economy is not an organism is obvious, that a micro-economy is not simply a macro-economy is much more difficult to understand.

First, there is no reason why a single firm cannot continue to innovate and successfully compete indefinitely. Its failure to do so lies in its human components, not its business ones.

Second, even in the case of individual firms’ declines, there is no reason why these individual cases necessarily result from the larger economy, nor is there any reason as to why these declines would inherently occur simultaneously throughout an economy. Far more likely growth, decline, and renewal happen continuously throughout an economy.

J.T. Young was Communications Director in Office of Management and Budget (2003-2004) and Deputy Assistant for Tax and Budget Policy at the Department of Treasury (2001-2003) in the Bush Administration.